Cyprus Bailout Woes Harmful to EU Strategic Interests

'Abject Error':How the Cyprus Deal Hurts EU Strategic Interests

A Commentary by Jeffrey Stacey

AP/dpa

The EU approach to Cyprus hasn't just damaged the country's economy.

The euro-zone bailout of Cyprus exposed deep divides within Europe and also brought back the specter of the euro crisis. In addition to harming the island nation's economy, errors made in negotiating the deal will ultimately be a setback to strategic EU interests as well.

Investors keep getting burned in betting on members exiting the euro zone, let alone the break-up of the European Union's common currency. And economics experts keep getting their predictions wrong. The simple reason: The EU, on the economic front as well in other policy areas, is at its heart a political project. Events continue to show that despite the painful strains of major economic duress, this commitment remains intact.

Despite the messy manner in which its member state governments deal with crises -- chaos largely explained by institutional reasons rather than by incompetence -- the EU and the euro are here to stay. The EU certainly has some major restructuring to do in terms of establishing the necessary banking and fiscal unions, and it rarely looks good in a crisis. But it will carry on muddling through and, in a wider historical perspective, continue to provide its citizens with a considerable range of benefits -- just as it has for decades, particularly since the advent of the single market nearly 30 years ago.

Nonetheless, the EU made major mistakes in the bailout of Cyprus, to the point that it almost failed completely. Even worse, the whole affair demonstrates a distinct inability to act strategically when the stakes are high. Repercussions from this episode that haven't been captured in the headlines will continue to reverberate for years. And, it should be noted, it was politics that accounted for bringing back the specter of crisis, not economics.

The Cypriots are certainly responsible for a range of significant mistakes on their own. For years the government artificially propped up its economy with illicit capital inflows primarily from Russian businessmen. It also allowed its banks to grow too large and didn't develop other elements of a standard Western economy. Furthermore, recently elected President Nicos Anastasiades engaged in unhelpful brinkmanship in a failed attempt to keep the country's business model intact.

Newly Ruthless Approach

But did these actions justify the harshness of the final deal and the risks that lay ahead for the EU? It would appear not.

Conventional wisdom suggests the newly ruthless approach of EU finance ministers toward Cyprus -- relative to past euro-crisis bailouts -- was due to citizens in Germany and elsewhere being fed up with having to stomach a lifeline being thrown to yet another profligate Southern European member state.

A more probable explanation, however, is the bitterness Northern European political elites still nurse from the early 2000s, when Greece blackmailed the EU into bringing Cyprus into the club. Greece threatened to veto Scandinavian aspirants should Cyprus not be allowed in. A healthy dose of anti-Russian sentiment no doubt played a role as well.

These primarily political factors led EU policymakers to a commit a glaring economic mistake -- that of seeking to implement a one-time levy on depositors, including insured accounts holding less than 100,000. The EU seemed not to realize that investors would see this as an EU money-grab by fiat. And it brought back a euro crisis that many had thought was largely over.

It was an abject error, and completely unnecessary. The EU was so bent on putting its boot on the Cypriot neck that it neglected to think through the acute danger of setting off bank runs around the region by violating its own banking deposit guarantee. As an example of group think, it was a thing of beauty.

Despite a final deal that preserved the bank deposit guarantee, the genie has escaped the bottle. And once genies are out, they don't go back in. Installing a banking union has become much more difficult as a result.

A Challenge for Peace

But it gets worse. In strategic terms the EU hurt not only Cyprus and itself, but also the interests of the US and other allies in the West. Europe pushed Cyprus directly into the arms of the Russian government. Not only did this hurt the prospects for its own deal, but it gave leverage to Moscow in the process.

More important still, however, by forcing Anastasiades between the rock of a forced bank levy and the hard place of seeking assistance from Moscow, the EU seriously undermined him domestically precisely when the West was about to reap the benefits at long last of a fairly pro-Western Cypriot president, crucially necessary to overcome sour relations with Turkey that continue to undermine NATO relations, EU relations, NATO-EU relations, and US relations with both.

To top it all off, a peace deal along the lines of the Annan Plan for a final resolution of the 40 year-old Cypriot divide -- the prospects for which had improved with the election of Anastasiades -- has seen its prospects diminished.

It is a myth that Anastasiades alone was responsible for at first wanting to impose a levy on savings accounts below 100,000. The Germans, after all, were complicit and actively in support, despite subsequent denials from Berlin. But it is also a myth that Germany was alone in pressuring the Cypriots. The Dutch, Finns and Austrians were equally adamant, as were the European Central Bank and the International Monetary Fund (meaning the US cannot completely escape blame either). Each bears a degree of responsibility for this debacle.

Dr. Jeffrey Stacey was an EU and NATO specialist at the State Department during President Obama's first term. He is currently writing a book about Europe as a senior visiting fellow at the Center for Transatlantic Relations at SAIS Johns Hopkins in Washington DC. He is author of "Integrating Europe" for Oxford University Press.

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Regarding the claim that the US bears some responsibility for the Cyprus crisis because of the IMF, I guess it depends on what "US" means. If "US" means the elites of the US, maybe. If it means the [...]

Regarding the claim that the US bears some responsibility for the Cyprus crisis because of the IMF, I guess it depends on what "US" means. If "US" means the elites of the US, maybe. If it means the substantial majority of the citizens in the US, no. We have absolutely no say whatsoever in the IMF.
I would suggest a thought experiment: If there was an up or down national referendum on whether the US should provide any more money to the IMF, what do you think the vote would be? I would say 85 - 90% would vote to leave the IMF/cut off all funding.

2. enough blame to go around

Sarah_Thustra 04/03/2013

Some people never get tired of finger pointing. What is most apalling is the inability of those overpaid "leaders" to grasp how fundamentally broken and finished the system is.
Nothing short of suicide by Mr. Draghi [...]

Some people never get tired of finger pointing. What is most apalling is the inability of those overpaid "leaders" to grasp how fundamentally broken and finished the system is.
Nothing short of suicide by Mr. Draghi of ECB would reflect the severity of the Euro mess.